Most of us will have looked at one of our payslips and thought to ourselves, maybe even exclaimed out loud, “I swear I didn’t pay that much tax last month!” Well, the chances are, we probably didn’t.
For many, taxation can be quite a scary concept; however, we believe that when clearly explained, it's really not all that hard to understand. In this guide, we'll break down the concepts of income tax brackets, codes, rates, and more, to help businesses and employees better understand income tax.
"Nothing is certain in life except death and taxes." Benjamin Franklin
We’ll start by explaining tax codes and how they influence how much tax someone pays.
All English tax codes are composed of numbers and suffixed with a letter; in Scotland and Wales, the same tax code will be prefixed by either S (for Scotland) or C (for Wales).
The numbers within someone’s tax code relate to the amount of tax-free personal allowance (PA) they are entitled to in that particular job throughout the tax year.
One of the most common tax codes in England throughout the 2022/2023 tax year was 1257L. Anyone with this tax code had a PA of £12,570 within on particular job or pension.
To put it simply, the numbers in someone’s tax code relate to the amount of PA that person is entitled to throughout the year for that employment or pension—e.g. a 609T tax code would mean that a person receives a PA of £6,090 and 1375M would equate to a PA of £13,750.
So, now that we understand what the numbers mean, we can begin to look at the letters.
As we now know, letters can be both a prefix and a suffix in a tax code.
In the UK, depending on the combination of prefixes and suffixes, several different tax categories exist. Furthermore, all tax codes can potentially be suffixed with an M1, W1 or X to indicate an emergency tax code. It’s worth noting:
the first four letters - L, M, N, and T - are suffixes, meaning they are added to the end of the tax code. (i.e. 109T or 1257L).
The following three letters can be ‘prefixed’ on any of the tax codes above, for example, S109T or C1257L .
While code ‘K’ is a prefix, it shouldn’t be attached to a code with a suffix, for example, K190
a 9 should be added to the end of any tax code number if there is additional income to add when calculating tax due
|Tax code||What it means|
|L||You are entitled to the standard tax-free allowance|
|M||You've received 10% of your partner's Personal Allowance|
|N||You've transferred 10% of your Personal Allowance to your partner|
|T||Temporary tax code, HMRC require more info|
|M1/W1/X||Emergency tax code, pay and tax is treated as if it was the first period of the tax year so tax is not calculated on the year to dates|
|S||Scottish rates apply|
|C||Welsh rates apply (currently the same as in England)|
|K||Adjustment tax code. No free pay allowance given, instead, a 9 should be added to the end of the number|
|BR/CBR||20% (no free pay allowance)|
|D0/CD0||40% (no free pay allowance)|
|D1/CD1||45% (no free pay allowance)|
|SBR||Scottish basic rate (no free pay allowance)|
|SD0||Scottish intermediate rate (no free pay allowance)|
|SD1||Scottish higher rate (no free pay allowance)|
|SD2||Scottish top rate (no free pay allowance)|
|NT||Income is not taxable|
Changes to a tax code
Someone's circumstances may change throughout the year which could lead to a change in the tax rate.
Most people will have cumulative tax codes, and these are the easiest to identify as they do not include 'W1', 'M1', or 'X'. If a tax code is suffixed by any of these, it is considered an "emergency tax code".
A cumulative tax code calculates someone's total tax based on their overall year-to-date earnings and tax paid.
An emergency tax code only looks at the current month's earnings and treats it as if it were the first period of the tax year.
Someone who has an emergency tax code will not benefit from any accumulated personal allowance, nor will they be liable to any under or overpayments of tax. Finally, they are also more likely to be hit by a higher tax threshold.
How much tax do people pay?
The tax rates and thresholds for Scotland, England and Wales are independent of each other. However, at the point of writing, the current Welsh rates and thresholds are the same as those in England.
To establish what percentage of tax has to be paid, it is important to determine how much of someone's earnings fall into each tax bracket. The tax rates and thresholds for the 2023/24 tax year are as follows.
Scottish income tax brackets
|47%||Earnings above £125,140|
Income tax brackets for Wales and rest of the UK
|45%||Earnings above £125,140|
A simple way of explaining the process is to use Jane's earnings as an example.
Jane lives and works in London and earns exactly £60,000 a year. Her tax code is 1257L, which means that she has a PA of £12,570.
How is Jane's salary taxed?
① Because her tax code is 1257L, the first £12,570 she earns is tax free
② The following £37,700 she earns are taxed at 20%
③ The next £9,730 are taxed at 40%
Over and underpaying tax
How many of us have received a letter (a P800) through the post from the taxman asking for more money? Speaking from experience, it's pretty annoying when it happens.
However, when it's the other way round, and we receive a letter (surprisingly also called a P800) saying that we're due a rebate, the feeling (I'd imagine) would be pretty satisfying.
While this is a relatively common occurrence, HMRC do their level best to avoid this happening. Typically, if an employee has over or underpaid in a previous month, a cumulative tax code will correct this.
This means that if an overpayment or underpayment has occurred, the person affected will likely pay either more or less tax the following month—providing it is still the same tax year.
Processing corrections like this minimises the likelihood of HMRC approaching someone at the end of the tax year to recoup owed tax. It also reduces the delay for someone expecting a tax refund.
Notes for underpaying tax
If the amount owed by someone is less than £3,000, HMRC will adjust their tax code in the next tax year in order to ensure that they can reclaim the correct amount.
If the amount is £3,000 or more, HMRC will contact someone regarding the ways that they can repay the outstanding amount.
The P45 is a PAYE form that someone will receive from an employer when they stop working.
If a new employee provides their employer with a P45, it will contain previous pay and tax figures if they were on a cumulative tax code. If they were on a non-cumulative tax, however, their previous pay and tax figures won't appear on the P45 section they hand to their new employer.
Just as in the preceding section, which referred to under and overpayments of tax processing, a P45 will lead to the employee’s tax position being recalculated.
In most instances, there will be no change for the employee, but if the P45 figures show an under or overpayment of tax, this will be amended in the next payroll.
A change in earnings
Each month, an employee's tax calculation considers the year to date earnings for that tax year, up to that point.
If someone's pay changes, they may be liable to pay either less or more tax. For example, if an employee works overtime or receives a bonus or increase in pay, their taxable pay may increase.
Alternatively, if a person earning enough to pay a higher tax rate sees a decrease in the amount of money they earn, they may be liable to receive a tax rebate.
An employee's PA will change when they earn over £100,000. For every £2 they earn above that amount, they lose £1 from their PA. If they predict their earnings will surpass this amount, they should contact HMRC and request a tax code review.
The regulatory limit
The regulatory limit is set by HMRC and is in place to put a cap on the amount of tax that can be deducted from an employee, particularly if an employee owes tax from previous months.
The limit set means that an employee can be deducted no more than the equivalent of 50% of their gross pay. Consequently, an employee whose monthly gross pay is £2,000 will never pay more than £1,000 in total deductions.
🎤 💥 Myth-busting
Income tax only becomes payable once an employee has reached their annual PA threshold.
The annual PA is divided by the number of pay periods the employee is paid over. For example, if an employee is paid monthly, they are entitled to 1/12th of their annual PA each month. This accumulates as the months go by if they're on a cumulative tax code. Any earnings that exceed this amount are taxable.
An employer knows why a tax code has been applied to an employee.
HMRC protects employee data and employers will never know why an employee's tax code is what it is. Tax codes are influenced by more than just payroll earnings, so if an employee is unsure why their tax code has changed, they can log in to their personal tax account to check this.
An employer can intervene if an employee thinks their tax code is incorrect.
If an employee thinks their tax code is incorrect, then they must get in touch with HMRC. An employer can only apply a change in tax code upon receipt of the proper notices from HMRC and not on the employee's word.
HMRC is responsible for monitoring someone's tax and tax code to ensure the correct payments are made.
HMRC can only understand someone's tax position from the figures they receive. Therefore, it is the individuals' responsibility is to monitor any changes to benefits and earnings—in and outside of employment—to ensure that they are correct. If someone is unsure, then they should contact HMRC immediately (doing so through their personal tax account is the easiest way).
To sum up...
While tax may be the bane of many people's lives, it's important to remember that it's a necessary evil.
It's also valuable to understand what the tax code on a payslip means and the reasons as to why someone is taxed a particular amount.🤔 Want to find out more?
If you're an employer and would like to find out how PayFit can support you with your payroll processes, why not book a demo with one of our product specialists today?
The information contained in this document is purely informative. It is not a substitute for legal advice from a legal professional.
PayFit does not guarantee the accuracy or completeness of this information and therefore cannot be held liable for any damages arising from your reading or use of this information. Remember to check the date of the last update.